Corporate tax burdens in Arizona are among the heaviest in the nation. Arizona's in-state tax burden and its total effective corporate income tax rate are the highest in the immediate region. The state's property tax burden on businesses is the sixth highest in the nation for certain classes of commercial property. Arizona's heavy corporate taxation is detrimental to capital formation and business growth, and discourages out-of-state entrepreneurs from setting up shop in the state.
There has been a great amount of talk lately about how to make Arizona more attractive to business. Unfortunately, the proposed solutions have generally ignored the root problem: Arizona's corporate tax burden. Instead, the proposals revolve around various industrial planning schemes that involve government granting special privileges to selected businesses and subsidizing certain business decisions.
Economic research over the last 30 years suggests that Arizona will not benefit by letting the government embark on such schemes in the name of economic development. Industrial planning generally fails to stimulate growth, for the simple reason that government is rarely successful in picking winners and losers in an economy. And even where there are marginal gains to be made from showering tax money on selected businesses, it is unfair to tax some companies for the benefit of their competitors. Instead of engaging in industrial planning, Arizona's policymakers should cut taxes for all businesses.
This study proposes and defends six business tax reforms and projects their revenue implications. The reforms are ranked from least to most aggressive:
- Equalize state income tax rates, so that the top rate on corporate income taxes is the same as that for personal income, currently 5.04 percent.
- Lower the corporate income tax rate to a regionally competitive level, from 6.97 to 4.63 percent, Colorado's flat tax rate.
- Suspend the unemployment tax for at least a year, and lower the rate thereafter.
- Suspend the unemployment tax and lower the corporate income tax rate to a regionally competitive rate.
- Eliminate the corporate income tax.
- Eliminate the corporate income tax and suspend the unemployment insurance tax.
The last option, abolishing the corporate income tax in conjunction with a suspension in the unemployment insurance tax, is the best option available to Arizona's legislators. If enacted in a single year, it could lead to the creation of approximately 150,000 new jobs and boost payrolls in the state by $5.4 billion. The option would be revenue-neutral during the first year. A permanent reduction of the unemployment insurance tax to 0.5 percent would make the option revenue-neutral for the foreseeable future.